Saturday, April 15, 2017

Noah Smith: "Why the 101 model doesn't work for labor markets"

A lot of people have trouble wrapping their heads around the idea that the basic "Econ 101" model - the undifferentiated, single-market supply-and-demand model - doesn't work for labor markets. To some people involved in debates over labor policy, the theory is almost axiomatic - the labor market must be describable in terms of a "labor supply curve" and a "labor demand curve". If you tell them it can't, it just sort of breaks their brain. How could there not be a labor demand curve? How could there not be a relationship between the price of something and how much of it people want to buy?

Funny thing is this is pretty similar to what Sandwichman is saying in Boundless Thirst for Surplus-Labor. The "lump of labor" is a partial equilibrium model and rebuttals to the "fallacy" also invariably rely on partial equilibrium models. They are both wrong.

7 comments:

How to overcome the manifest silliness of Econ 101 and save the economyComment on Noah Smith on ‘Why the 101 model doesn’t work for labor markets’

The Econ 101 labor market theory does not work because it is based on microfoundations. Microfoundations are given with the neo-Walrasian axiom set: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

From these axioms together with some auxiliary assumptions follows what Leijonhufvud famously called the Totem of Micro/Macro, that is, SS-curve―DD-curve―equilibrium, which is the representative economist’s all-purpose tool.

This approach is false on all methodological counts, that is, supply-demand-equilibrium is a NONENTITY. General inapplicability implies that it is also inapplicable to the labor market.

Microfoundations is the wrong approach. This explains why economics is a failed science. The correct approach is macrofoundations.#1

The elementary version of the correct (objective, systemic, behavior-free, macrofounded) employment equation is shown on Wikimedia:#2https://commons.wikimedia.org/wiki/File:AXEC62.png

From this equation follows:(i) An increase of the expenditure ratio rhoE leads to higher employment L (the Greek letter rho stands for ratio). An expenditure ratio rhoE greater than 1 indicates credit expansion, a ratio rhoE less than 1 indicates credit contraction.(ii) Increasing investment expenditures I exert a positive influence on employment.(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

The complete employment equation contains in addition profit distribution, the public sector and foreign trade.

Item (i) and (ii) cover Keynes’s familiar arguments about aggregate demand. The factor cost ratio rhoF as defined in (iii) embodies the price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what standard economics teaches: “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price.” (Tobin)

The systemic employment equation contains nothing but measurable variables and is therefore readily testable. There is no need for further brain-dead supply-demand-equilibrium blather: as always in science, a test decides the matter.

Egmont Kakarot-Handtke

#1 The macrofoundations approach starts with three systemic (= behavior-free) axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

#2 For details see cross-references Employmenthttp://axecorg.blogspot.de/2015/08/employmentphillips-curve-cross.html

The theoretical construct known as "the labor demand curve" is ontologically suspect, i.e. it is a poor modeling choice. If we adopt some sort of positivist or empiricist philosophy - "if I can't observe it, it might as well not exist" - then we might as well say that "the labor demand curve" doesn't exist. It's not an actual thing.

Of course, I would say the same thing about the construct labeled, "market". Maybe the problem begins with trying to "understand markets" in circumstances where "market" is not an observable thing, but just a poor choice of metaphor. I think there are markets, but any kind of labor market would be exceptional. Maybe there is a market for day labor at the curb near Home Depot, but most people work in an employment relation which is embedded in a persistent hierarchy. Nothing like a market; no bidding, for example; the actual quantity of labor time exchanged is managed administratively.

If we are going to analyze the problems of wages and hours worked, the partial equilibrium nature of the argument might be less important a deficiency than the unrealism of talking as if there is a market, where almost no one experiences a market.

In the context of working as an employee in a managed hierarchy, one thing that is abundantly clear is that no one is being paid for a metered stream of labor services. People are being paid contingent on following direction and they are part of a scheme for controlling a production process, to reduce waste and error. There is not really a lot of scope in most production processes for gross substitution of the kind routinely imagined in Econ 101 discussion. What managers manage is not the efficient allocative mix of labor with capital -- in most production system designs there are a fixed number of operator seats; no matter how cheap is labor, no one is going to add a second driver to a farm tractor -- what managers manage is waste and slack. If labor is cheap and unconstrained, managers will choose an easy life for themselves and waste the time of the marginal employee. Schedules may be chaotic, training neglected, turnover run out of control.

If we are to have any hope of thinking thru the economics of labor, we will have to explicitly admit hierarchy and let the market metaphor go.

Then we might tackle the problem of marginal waste of labor time more directly. Not only that we might like to create more jobs with limits on time worked, we might like to create more lives lived with increase allocation of time to private activities and reduce wasted efforts in wasteful, wasted activity at work. Most American produce marketing, salesmanship, and financial services, bullshit things that would leave the society better off if we just produced less of them at the margin. That is the equilibrium I would have policy focus on.

Thanks for your insights, Bruce. Totally agree and especially like your observation about what managers do is manage waste and slack. Are you familiar with Kenneth Burke's satirical article from 1930 on the political economy of waste, "Waste – the future of prosperity," which he later realized ("Borrow. Spend. Buy. Waste. Want") was not as whimsical as he had supposed?

But if - in the spirit of bruce's remarks - one ceases to talk of markets and starts to talk of hierarchies and social coordination, one then has to have a different idea of money, one has to talk of power - an essentially unmeasurable relation, of classes and orders and history. In short, one has to become a sociologist.

Supply-demand-equilibrium is one of the most annoying constructs in the history of sciences but every student generation since Walras/Jevons/Menger swallowed this methodological crap without turning an eyelid.

Nobody with two brain cells can start with a NONENTITY like utility maximization, derive phantasmagorical functions and then wonder why econometrics runs straight into an identification problem.

It is NOT so that there were no timely warnings from genuine scientists: “Walras approached Poincaré for his approval. ... But Poincaré was devoutly committed to applied mathematics and did not fail to notice that utility is a nonmeasurable magnitude. ... He also wondered about the premises of Walras’s mathematics: It might be reasonable, as a first approximation, to regard men as completely self-interested, but the assumption of perfect foreknowledge ‘perhaps requires a certain reserve’.” (Porter)

Every economist who has accepted supply-demand-equilibrium as a reasonable description of how the market system works has flunked the competence test.* There is no way around the nullification of all scientific credentials (Master, PhD, Peer Reviewer, Editor, Professor, Nobel Laureate) economists ever received since Walras/Jevons/Menger. Heterodox economists are NOT exempted because they failed to develop an alternative to supply-demand-equilibrium since Veblen.

Egmont Kakarot-Handtke

* See ‘How to Get Rid of Supply-Demand-Equilibrium’https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2263172

Psychology, sociology, politics, history have to be left to psychologist, sociologists, political scientists, and historians.#2 Economics is about how the economic system works.

Supply-demand-equilibrium is based on behavioral axioms (= microfoundations) and because of this methodological blunder the whole analytical superstructure as presented in the textbooks since 60+ years is provable false.#3

Econ 101 doesn’t work for the labor market and it doesn’t work anywhere else.

Economists’ memo: If it isn’t macro-axiomatized, it isn’t economics.

Egmont Kakarot-Handtke

#1 See ‘Methodology 101, economic filibuster, and the mother of all excuses’http://axecorg.blogspot.de/2016/12/methodology-101-economic-filibuster-and.html